In his 1984 book The Goal, Eliyahu M. Goldratt introduces a management concept called the theory of constraints (TOC). TOC was first developed within the framework of manufacturing but has since been applied to all types of businesses that want to function more efficiently, particularly those that deal with inventory. “Every action that brings a company closer to its goal is productive,” Goldratt writes, which seems simple enough; except, as you well know, businesses can’t simply operate at peak performance at all times. That’s where the constraints come in.
The 3 Measures of Success
Goldratt succinctly lays out the basic goal that most for-profit businesses desire: “to make money by increasing net profit, while simultaneously increasing return on investment and increasing cash flow.” While each business has it own auxiliary hopes and values, turning a profit is the raison d’etre for a business—otherwise it wouldn’t be in business. To track your progress along this goal, Goldratt suggests measuring 3 important factors:
- Inventory, or the amount of money a business spends to acquire and/or create the goods it intends to sell.
- Operational expense, involves all the costs associated with turning inventory into sales.
- Throughput, refers to the rate at which businesses turn inventory and operating expenses into revenue. TOC presumes that making decisions based on these factors and how they affect your business will help you achieve your goal.
Of course, businesses don’t operate in a vacuum. They have to work around countless constraints, both internal and external. Some constraints, like safety standards, should not be tinkered with under any circumstances. Yes, it might be faster to run your warehouse without safety harnesses, but it’s not an actionable method for increasing productivity. Instead, you need to focus on internal constraints that are fixable and don’t come with significant drawbacks.
Policy, equipment, and people are all common sources of constraint on a business. Identifying where your organization falls short in these areas is the diagnostic step that allows you to treat what ails your company. Let’s say, for example, you’re running a retail clothing shop where inventory sits in the back for 7 to 10 days before hitting the shelves. Let’s assume, also, that this inventory turns over about a month after, creating sales without excessive marketing spend. In this scenario, your throughput is being hurt simply by virtue of the amount of time it takes to get the inventory from the back of the store to the front. Is it a people problem where employees don’t feel urgency to get goods out of storage? Is it a lack of equipment in the form of racks and shelves that limits the amount of merchandise in the store? Once you know the problem, you can go about remedying it.
Situations like these are part of doing business, and while each organization or even each department or location will have its own alterable constraints, all companies have them. In a multi-channel retailing environment, constraints can also occur within one area of the business. Your brick-and-mortar retail and Amazon storefronts may be highly productive while your e-commerce site falters. When investigating possible constraints, you need to be willing to look everywhere.
How AccountingSuite™ Helps By Providing Visibility
AccountingSuite’s exceptional inventory management tools can provide insights into inventory, operational expenses, and throughput. These data points can clue you into where the business is constrained. On top of that, it comes with project management functionality to help assess people constraints in a quantitative methodology. It’s a great solution for those who want to work smarter toward achieving their goals. Click here for a free trial.